February 11, 2008

Three interesting comments were posted to the blog over the past week, and I answered them tonight. I'm re-posting them here so you can all see the answers.

1. From Dom, re: "Predicting the Market":

If we can use the tools to see what the big boys are doing and predict stock prices, why can't we do that with the stock market? If we know that the PE of the market is generally 10, shouldn't we be able to buy when it is less and we have 3 arrows? Also, should we continue to use a PE of 10 or should we consider bumping it up like we do for our future sticker prices?

Basically, if we know that a good company is going to grow at its historical rate, couldn't we also say that the markets will grow at their historical rates? If so, couldn't we use the tools to predict them the same way we predict stock prices?

You make a good point. First, though, the market averages a PE of about 15, not 10. A market PE of 10 is low. The problem with relying on a market PE is the same problem we have relying on a PE for a business. I wish it was that simple but it isn't. PE's reflect expectations of growth. Thus a company with a high PE might be a lot cheaper in the long run than one with a low PE, depending on what you pay for it. When we look at the whole market, all we can do is make the reasonable assumption that in the long run the market is going to do well.